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October 8, 2012

In recent weeks, we have been closely monitoring a flurry of activity among many banking organizations to respond formally to the proposed Basel III rules. With few exceptions, the response of the banking industry, particularly with respect to the impact of the proposed Basel III rules on community-focused financial institutions, has been roundly negative.

In mid-September, U.S. Senator Mark Warner (D-VA) and U.S. Senator Pat Toomey (R-PA) circulated a letter to the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation that has garnered the signature of 51 of their colleagues in the U.S. Senate. The senators’ letter raises their concerns with the “significant, unintended consequences for community banks” that may stem from the proposed capital rules that would make it tougher for smaller banks to raise capital or result in reduced lending in the communities they serve.

Another prominent critic of the proposed rules has been FDIC Director Thomas Hoenig, a former chief executive of the Federal Reserve Bank of Kansas City, who recently proposed that the entire Basel III proposal be scrapped in favor of a more simple capital calculation based on tangible common equity ratios. While Director Hoenig’s proposal would result in higher minimum capital requirements for all banks, it could potentially avoid many of the pitfalls associated with the proposed rules, particularly with respect to the complex deductions from capital and new asset risk-weights that are part of Basel III.

Director Hoenig’s concerns are largely echoed in a recent statement issued by the Conference of State Bank Regulators (CSBS), a nationwide organization of state banking regulators. Although CSBS indicates that it does support higher minimum capital thresholds for all banks, the CSBS’ comments directly challenge many of the new risk-weights assigned to certain classes of assets, deeming the new risk-weights to be without significant empirical support. New risk-weights that are singled out for particular criticism by the CSBS’s comments include narrow definitions for so-called “low risk” home mortgages, as well as “high volatility commercial real estate exposures” (which we have commented on here) that would significantly curtail the product offerings available to the customers of community banks.

While none of these criticisms of Basel III is the same, there are several common threads that relate to the potential impacts of many of the new asset risk-weights, as well as certain aspects of the new capital standards, particularly with respect to the exclusion of trust preferred securities from tier 1 capital, the capital conservation buffer and certain deductions from capital. While these issues have been broadly explained by the comments made by many of the trade groups, individual banks and bankers need to tell their particular stories in the form of comment letters to the Federal Reserve.

We have recently heard the Federal Reserve Board in Washington, DC is continuing to push for these rules despite significant public criticism. In our view, until the policymakers in Washington hear of the specific negative impacts of the proposed Basel III rules on not just community banks, but also the communities they serve, they are unlikely to change course. We urge bankers — regardless of the size of their bank — to make their voices heard in the coming weeks.